Australia | Mar 14 2018
This story features G8 EDUCATION LIMITED. For more info SHARE ANALYSIS: GEM
G8 Education is transforming its operations to take advantage of an expected improvement in industry dynamics.
-Will the expected increase in demand be sufficient to overcome an oversupply?
-Current fundamentals provide attractive entry point to the stock
-Tighter funding environment signals supply may be moderating
By Eva Brocklehurst
Brokers find the current valuation of child care provider G8 Education ((GEM)) undemanding, although uncertainty surrounding occupancy keeps several from being more positive. The company is intent on transforming its operations and increasing occupancy levels while government rebate changes, due in July, are expected to improve the industry's dynamics.
Industry players are expected to benefit from the increased flexibility provided by the new regulations and a reduced regulatory burden, yet Macquarie is among brokers that wonder whether a resultant increase in demand will be sufficient to overcome the oversupply of child care places that is dragging down the market.
The company missed earnings guidance at its February results, despite a downgrade to forecasts being provided as late as December. This outcome implies poor operating visibility, Macquarie asserts, while Deutsche Bank also believes soft occupancy numbers, discounting and increased capital expenditure mean a turnaround is unlikely in the near term.
Perhaps the growth opportunity that should prevail in a better government funding environment will provide opportunities and benefits by 2019, UBS suggests.
Wilsons was surprised the company did not provide quantitative guidance for the first half of 2018 at its results briefing, and considers this is a direct result of uncertainty about occupancy in the near term, as well as price discounting. The latter is most pertinent to G8 Education because of its material exposure to NSW, where competition is strongest.
Sector conditions must improve before the broker, not one of the eight stockbrokers monitored daily on the FNArena database, moves from a Hold recommendation and target of $2.89. On the other hand, Morgan Stanley believes the stock is a good buying opportunity at the end of a downgrade cycle, maintaining an Overweight rating.
The company has renewed its management and board and Morgans expects this will contribute to the transformation. A capital management review was also undertaken in 2017, which resulted in a strong balance sheet, improved debt funding and reduced gearing, ensuring in the broker's view the company is well placed to participate in industry consolidation.
Current occupancy challenges are more cyclical than structural in Morgans opinion, and while these are likely to persist for the near term, fundamentals provide an attractive entry point to the stock. Morgans initiates coverage with an Add rating and $3.53 target. The broker believes the company can grow via acquisitions and organically, and improve its operating efficiencies with a more stable regulatory and supply backdrop.
Morgans also notes that private-equity backed Affinity Education is for sale. This is one of the largest for-profit child care operators, with around 160 centres compared with G8 Education at 516 centres. If G8 were to acquire the group it would require significant equity/debt, the broker surmises. Nevertheless, G8 can leverage its size and achieve economies of scale relative to smaller operators.
Oversupply was the issue in 2017 and this is expected to be a challenge throughout the first half of 2018. Yet Morgans points to the tightening of bank funding to operators and developers as a sign supply is beginning to moderate.
Other market players have also observed that fewer centres are under construction and fewer development applications are being lodged. Some of the occupancy issues in 2017 have been internally generated, so Morgans suggests there is scope for improvement in terms of better conversion and lower staff turnover.
While earnings are yet to re-base, Wilsons acknowledges occupancy would need to decline to around 70.0% from 2017 levels of 76.7% before debt covenants come under pressure. The broker expect supply for the sector to take at least 15 months to get back to equilibrium, based on 276 new centres being opened in 2017 that was 1.4x the demand.
The broker believes lenders to larger child care centres typically work to covenants of around 3.0x net debt/EBITDA (operating earnings). G8 Education has restructured its debt the past 12 months and this means net debt/EBITDA will decline to 1.2x in FY19, which provides head room, particularly given a strong cash flow.
FNArena's database shows four Buy ratings and two Hold. The consensus target is $3.69 suggesting 33.2% upside to the last share price. The dividend yield on 2018 and 2019 forecasts is 7.4% and 8.1% respectively.
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